Machinima is defined as "animated filmmaking within a real-time virtual 3-D environment".
Machinima is recorded in real-time, and real people can act and control the camera. Essentially you use a screen capture tool such as FRAPS or Jing (Camtasia) to record and edit the real time activities in a virtual environment such as SL or an online game. You then use the tools to edit sound and video. With careful planning, artistry, and some reasonable easily acquired skills the end product is very good. This lovely piece by Bryn Oh is an excellent example. World Expo Shanghai-No Love
Make sure you watch it in the full screen player. 
